DBRS Morningstar Confirms the Kingdom of the Netherlands at AAA, Stable Trend

DBRS Ratings Limited (DBRS Morningstar) confirmed the Kingdom of the Netherlands’ Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Kingdom of the Netherlands’ Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings remains Stable.

KEY RATING CONSIDERATIONS

The confirmation of the Stable trend reflects the Netherlands’ solid credit fundamentals amid sound economic performance. While growth of the Dutch economy decelerated in 2019, growth is estimated above the euro area average. Labour market conditions remain strong, with unemployment at low levels. At the same time, the government debt-to-GDP ratio is estimated to have declined below 50% in 2019. Moreover, vulnerabilities stemming from the private sector, related to high household debt relative to income and high house prices, seem contained. The authorities have adopted measures over the past few years to improve the resilience of households and banks.

The ratings are supported by the Netherlands’ advanced, wealthy, and productive economy, its strong external position and its robust institutional framework. These credit strengths counterbalance the challenges associated with high household indebtedness and the economy’s exposure to external shocks given its high degree of trade openness.

RATING DRIVERS

In light of the Netherlands’ credit strengths and solid economic performance, downward pressure on the ratings seems unlikely. Nevertheless, a severe deterioration in growth prospects or public finances, damaging the Netherlands’ resilience to shocks, could lead to a Negative rating action in the long term.

RATING RATIONALE

The Dutch Economy Is Still Growing Faster Than the Euro Area and The External Sector Remains Robust

Growth of the Dutch economy is slowing. In its latest forecast, the Netherlands Bureau for Economic Policy Analysis (CPB) has estimated that the Dutch economy grew by 1.7% in 2019, down from 2.6% in 2018 and a recent peak of 2.9% in 2017. Growth has moved to its potential rate sooner than anticipated. For 2020, the CPB’s growth forecast is 1.3%. The slowdown mainly reflects weaker external demand, while domestic demand has remained robust. Wage growth and employment growth are supporting private consumption. Stimulative fiscal measures, including higher public investment, are also providing a boost to economic activity.

Downside risks to the economic outlook are related to a more severe slowdown in global trade or the economies of key trading partners, including Germany and the United Kingdom (UK). On global trade, De Nederlandsche Bank (DNB) has estimated that under an escalating trade conflict scenario, Dutch economic growth could be 0.5 percentage point lower in 2020. The Netherlands is also exposed to the UK’s departure from the European Union, as the UK is the Netherlands’ third-largest export destination in terms of value. The CPB has estimated that the GDP loss in the long-term could be 1.2% under a WTO scenario and 0.9% under a free-trade agreement scenario for Brexit. Domestically, public expenditure could turn out lower than planned, leading to lower real GDP growth. Efforts to cut nitrogen emissions could also affect construction and infrastructure projects.

Still favourable economic conditions have led to very low unemployment, but also to shortages in the labour market. At 3.5% in H2 2019, the unemployment rate is below the 5.0% long-term average. Tightness in the labour market is pushing wages up. Higher wages, the increase in the lower VAT rate and higher energy taxes pushed the inflation rate to 2.7% in 2019, but inflation is projected to ease to 1.4% in 2020. Tightness in the labour market is also contributing to more rapid growth in permanent employment contracts than in flexible contracts. This is a positive development given the relatively high share of flexible contracts and self-employed workers that had raised concerns over labour market segmentation and its potential effect on labour productivity. Measures to tackle this dualism have also been adopted.

The Netherlands’ economy continues to benefit from high levels of employment, productivity, and education. GDP per capita is one of the highest in Europe, almost 20% above the Euro area average. The level of private sector savings is also sizeable. Households’ pension savings and insurance products account for just over 50% of total household assets, which are among the highest of OECD countries. Aggregate high incomes and savings provide the Dutch economy with an important degree of resilience.

The Netherlands’ external position is also very strong, largely reflecting its trade competitiveness. A robust trade performance and high net savings in the private sector have helped maintain the current account in surplus since the early 1980s. The surplus has averaged 9% of GDP over the past five years, in part supporting the Netherlands’ large net external creditor position, on average at 57% of GDP since 2014. The strong external position provides the country with a significant buffer to absorb external shocks. This supports DBRS Morningstar’s assessment for the Balance of Payments building block.

Risks to Financial Stability Are Contained

Dutch household debt relative to income, while falling, remains one of the highest of OECD countries. Household debt was 217% of disposable income in 2018. At the same time, the aggregate net worth of Dutch households is the highest among OECD countries at almost 700% of net disposable income. Nevertheless, high household debt could exacerbate an economic downturn in case of negative shocks. In particular, households with low incomes and many first-time homebuyers are exposed to income shocks and declines in house prices. Vulnerability to increases in interest rates seems limited, as residential mortgages are largely fixed-rate. Debt partly reflects tax incentives and is largely in the form of mortgages.

At the same time, Dutch house prices continue to rise, although less strongly. Since the 2013 trough, house prices nationwide have risen by almost 40%, strengthening household balance sheets. Real estate assets account for about 20% of Dutch household assets. Prices are now above the 2008 peak levels and have risen at a stronger pace in the main Dutch cities. Housing investment has not kept up with housing demand. House price growth has eased, posting a 7.1% YoY on average in Q1-Q3 2019. But, if resumed, strong growth in house prices could increase the risk of a correction. A house price correction and an economic downturn could reinforce each other (for further details, please see DBRS Morningstar commentary entitled “The Dutch Housing Market: Booming Amid Modest Mortgage Lending – Risks to Financial Stability Contained”, available at www.dbrs.com).

Given the risks to financial stability and the economy posed by high household debt and rising house prices, and as part of the government’s tax reform, the Dutch authorities started to accelerate the reduction in mortgage interest deductibility in 2020, from 0.5 percentage points (pp) per year to 3.0 pp, until the target rate of 37.05% is met in 2023. Moreover, debt amortisation has been a requirement since 2013 to benefit from tax deductibility on interest expenses. This requirement has contributed to the decline in interest-only mortgages, which now account for about 50% of total mortgages. The limit on the loan-to-value ratio was also reduced in recent years, although to a still high 100% in 2018.

Furthermore, the DNB intends to impose a floor for risk weights on banks’ mortgage portfolios from the autumn of 2020 for a period of two years to improve the banks’ resilience. Mortgage lending remains moderate and the banking sector is in a healthy position. Dutch banks are profitable and well-capitalised. The large insurance sector, however, is facing challenges because of prolonged low interest rates and declining premium income.

The Government’s Expansionary Fiscal Policy is Underway but Public Finances Are Sound

The Netherlands benefits from effective public institutions and consensus-driven policies, which more than offset a somewhat fragmented political landscape. No single political party won a majority in the March 2017 elections. A new government took office in October 2017, after four parties (VVD, CDA, D66 and the Christian Union) presented their Coalition Agreement.

The centre-right coalition agreed to reform the tax system with the aim of reducing the tax burden on households and firms, and to increase investment in education, defence, healthcare and infrastructure. To partly finance higher expenditure, energy taxes and the lower VAT rate have been increased. The fiscal cost from the planned reduction of natural gas extraction is expected to be offset by windfalls. Overall, the government’s fiscal stimulus is equivalent to 2% of GDP between 2018 and 2022. The 2020 budget contains a more expansionary fiscal stance than expected, amounting to 0.9% of GDP, after 0.5% in 2019. Most of this expansion is in the form of additional tax relief for households, while tax burden on businesses will decrease by less than initially set in the coalition agreement. Some cuts to the corporate tax rate have been postponed to 2021.

DBRS Morningstar expects the government to maintain a sound fiscal position. The fiscal surplus is projected to decline to 0.2% of GDP in 2020, from an estimated 1.3% in 2019 and 1.5% in 2018, and the structural balance is projected to shift to -0.4% in 2020 from a positive 0.5% in 2019. While the budget position is set to deteriorate, the structural balance is projected to remain within the -0.5% medium-term objective.

The government debt-to-GDP ratio is also declining rapidly to moderate levels. In 2019, the debt ratio is estimated at 49.2%, almost 20 percentage points lower than the 2014 peak. Nominal GDP growth, privatisation proceeds, improving primary balances, and lower funding costs have contributed to the debt reduction. Moreover, the Dutch Treasury has continued to extend debt maturities and will increase the average debt maturity towards eight years. The Dutch Treasury also issued the Netherlands’ first sovereign green bond in May 2019, attracting strong demand from investors. A moderate debt ratio and a favourable debt profile support the shock absorption capacity of public finances.

The long-term sustainability of public finances looks secure. Over the past decade, the Netherlands raised the minimum retirement age, adjusted pension entitlements, and restrained healthcare spending. These measures have helped lessen ageing-related spending pressures. For the longer term, the government adopted the Pension Agreement in 2019 with the aim of achieving a more robust pension system. It also adopted the National Climate Agreement aiming at a more sustainable economy. The country’s effective public institutions, together with a robust fiscal framework, support the sustainability of public finances and overall economic policies.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.
http://www.dbrs.com/research/355850

EURO AREA RISK CATEGORY: LOW

Notes:

All figures are in euro (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include the Government of the Netherlands, Ministry of Finance (Ministerie van Financiën), Dutch State Treasury Agency (DSTA), Netherlands Central Bank (De Nederlandsche Bank DNB), Netherlands Bureau for Economic Policy Analysis (Centraal Planbureau CPB), Dutch National Statistical Office (Centraal Bureau voor de Statistiek CBS), European Commission (EC), European Central Bank (ECB), Eurostat, Organisation for Economic Co-operation and Development (OECD), IMF, World Bank, UNDP, BIS, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS Morningstar had no access to relevant internal documents for the rated entity or a related third party.

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Adriana Alvarado, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global Financial Institutions Group and Sovereign Ratings
Initial Rating Date: May 12, 2011
Last Rating Date: July 26, 2019

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